California is the eighth largest economy in the world, and it has a debt burden to match. It has outstanding general obligation bonds and revenue bonds of $158 billion, largely incurred for infrastructure. Of this tab, $70 billion is just for interest. Over $7 billion of California’s annual budget goes to pay interest on the state’s debt.

As large as California’s liabilities are, they are exceeded by its assets, which are sufficient to capitalize a bank rivaling any in the world. That’s the idea behind Assembly Bill 750, introduced by Assemblyman Ben Hueso of San Diego, which would establish a blue ribbon task force to consider the viability of creating the California Investment Trust, a state bank receiving deposits of state funds. Instead of relying on Wall Street banks for credit – or allowing a Wall Street bank to enjoy the benefits of lending its capital – California may decide to create its own, publicly-owned bank.

On May 2, AB 750 moved out of the Banking and Finance Committee with only one nay vote and is now on its way to the Appropriations Committee. Three unions submitted their support for the bill – the California Nurses Association, the California Firefighters, and the California Labor Council. The state bank idea also got a nod from former Secretary of Labor Robert Reich in his speech at the California Democratic Convention in Sacramento the previous day.

Why a State Bank?

California joins eleven other states that have introduced bills to form state-owned banks or to study their feasibility. Eight of these bills were introduced just since January, including in Oregon, Washington State, Massachusetts, Arizona, Maryland, New Mexico, Maine and California. Illinois, Virginia, Hawaii and Louisiana introduced similar bills in 2010. For links, dates and text, see here.

All of these bills were inspired by the Bank of North Dakota (BND), currently the nation’s only state-owned bank. While other states are teetering on bankruptcy, the state of North Dakota continues to report surpluses. On April 20, the BND reported profits for 2010 of $62 million, setting a record for the seventh straight year. The BND’s profits belong to the citizens and are produced without taxation.

The BND partners with local banks in providing much-needed credit for local businesses and homeowners. It also helps with state and local government funding. When North Dakota went over-budget a few years ago, according to the bank’s president Eric Hardmeyer, the BND acted as a rainy day fund for the state. And when a North Dakota town suffered a massive flood, the BND provided emergency credit lines to the city. Having a cheap and readily available credit line with the state’s own bank reduces the need for massive rainy-day funds (which are largely invested in out-of-state banks at very modest interest).

The Center for State Innovation, based in Madison, Wisconsin, was commissioned to do detailed analyses for the Washington and Oregon bills. Their conclusion was that a state-owned bank on the model of the Bank of North Dakota would have a substantial positive impact in those states, increasing employment, new lending, and government revenue.

What California Could Do with Its Own Bank

Banks create “bank credit” from capital and deposits, as explained here. Under existing capital requirements, $8 in capital can be leveraged into $100 in loans, drawing on the liquidity provided by the deposits to clear the outgoing checks. Assuming a 10% reserve requirement (the amount in deposits normally held in reserve), $8 in capital and $100 in deposits are sufficient to create $90 in loans ($100 less $10 held back for reserves).

In North Dakota (population 647,000), the Bank of North Dakota has $2.7 billion in deposits, or $4000 per capita. The majority of these deposits are drawn from the state’s own revenues. The bank has nearly the same sum ($2.6 billion) in outstanding loans.

California has 37 million people. If the California Investment Trust (CIT) performed like the BND, it might amass $148 billion in deposits. With $12 billion in capital, this $148 billion could generate $133 billion in credit for the state (subtracting 10%, or 14.8 billion, to satisfy reserve requirements).

There are various ways the state could come up with the capital, but one possibility that would not require new taxes or debt would be to simply draw on the treasurer’s existing pooled money investment account, which currently contains $65 billion in accumulated revenues dispersed to a variety of funds. This money is already invested; a portion could just be shifted to the CIT. Since it would be an investment in equity rather than an expenditure, it would not cost the state money. Rather, it would make money for the state. In recent years, the Bank of North Dakota has had a return on equity of 25-26%. Compare the 25-30% lost in the two years following the 2008 banking crisis by CalPERS, the California Public Employees’ Retirement System, which invested its money on Wall Street.

There are many inviting possibilities for applying the CIT’s $133 billion in credit power, but here is one easy alternative that illustrates the cost-effectiveness of the approach. Assume the bank invested $133 billion in municipal bonds at 5% interest. This would give the state close to $7 billion annually in interest income – nearly enough to pay the interest tab on the state’s debt.

Choosing Prosperity

What California can do with its own bank, other states can do as well, on a scale proportionate to their populations and economies. North Dakota has a population that is less than 1/10th the size of Los Angeles; the BND produced $62 million in revenue last year and $2.2 billion in loans. Larger states could generate much more.

We have been trapped in an austere neo-liberal economic model in which the only alternatives are to slash services, raise taxes, and sell off public assets, all in a futile attempt to “balance the budget” in a shrinking economy. We need to start thinking outside the box. We can choose prosperity, and public banks are a key tool for achieving that end.

Would love to see it. I hope every state can make the switch. After that, let’s create a National Bank! Then, after that, let’s take back control of our money supply and rid ourselves of this cancerous banking system that’s been eating away at our national sovereignty.

I wonder if you could clear up some confusion for me. In this last article, you stated that if a bank makes loans, it has to have an eqivalent liquidity to clear the cheques – that is, for every $100 in loans, the bank has to have £110 in deposits.

I was led to believe that, when a bank ‘creates’ the money for a loan, i.e, they simply write the amount into your account, the borrower spends this new money via a cheque or debit card, then the business or whoever pays that money into his or her bank account and this bank simply transfers the credit from the borrowers account to his or her bank account. In other words, all that is happened is credit has moved from the borrowers account to the business person’s bank account.

Perhaps I am being too simplistic here or have misunderstood the process.

Hi, I think you’re in the UK, right? I’d like to know myself if it’s the same there as here, but here, when checks leave the bank, they have to clear through the Fed or some other clearinghouse. That means that for every dollar going out, a dollar has to be coming in. It’s not that the bank actually LENDS the money coming in, since the loan was already made; but the bank borrows from the pool of “liquidity” created by the incoming deposits. If the bank doesn’t have the deposits, it can borrow them from other banks at the Fed funds rate till it can get them or make longer-term arrangements (e.g. buy CDs). If it’s as you say, even in England, how did Northern Rock manage to go bankrupt?

This blog is part of a series on the veracity of various bits of information floating around the topic of Monetary Reform….
Update: This is a UK website, and I am referring to the UK banking system only in this article…
Myth #1
“A bank keeps a 10% fraction of its deposits in reserve, and lends out the other 90%, this then arrives in another bank account, 10% is kept back, and it continues until there is nothing left”
Status: False!
This is perhaps the most commonly citied misnomer in Monetary Reform circles here in the UK. Due to partially incorrect (Update 2: certainly when referring to the UK system – for an academic challenge to the veracity of this “money multiplier” theory in the US, see Steve Keen’s paper – available here) analyses in films like Money as Debt & Zeitgeist it still persists despite the inaccuracies, and in the absence of an analogue for either film in the UK. Banking used to work in this way, but has not done so for over 20 years. Unfortunately, things are now a little bit more complicated.

The Myth
1. Bank A receives a deposit from Person A of £1000
2. Bank A keeps £100 in reserve (a 10% reserve ratio), and lends £900 to Person B
3. Person B uses the £900 to buy a car from Person C
4. Person C deposits the £900 into Bank B
5. Bank B keeps £90 in reserve, and lends £810 to Person D
6. The process continues until only 1p is kept in reserve

Before we continue, it is important to understand the difference between liquidity and solvency.
Liquidity – for a bank – is the ability to be able to meet demand for withdrawals when lots of people want to withdraw money at the same time, and this is what banks get to decide for themselves.
Solvency is the long-term stability of the banks finances, and is what “capital requirements” are designed to ensure. The theory goes that by making banks hold some capital back in reserve, they should be able to survive if somebody goes bust and cannot pay their loans back.
This old process above was designed to keep the bank both solvent and liquid.
The regulations were designed to cover the risk of a bank run, a liquidity buffer of 10% to ensure that there was enough money set aside to cover an unusual level of transfers or withdrawals in normal business. When there was a significant panic, however, Person A would find that his money was not actually available for spending as it had been put on loan, and there was not enough of somebody else’s money to cover their withdrawal request.
Banks ceased to use this system upon the switchover to the Basel Accords, and the loan process works differently now…

The Basel Accords
Liquidity buffers have now been done away with – you would think that this means that banks can now make as many loans as they wish, which is more or less the case, but not for this reason.
Banks get to decide their own levels of liquidity, and can decide themselves how much cash they keep set aside to cover an unusual spike in withdrawals. During times where there is a problem with liquidity banks can temporarily borrow from other banks on the “LIBOR” market (London Inter Bank Offered Rate) or be given some extra money from the Bank of England.
Extra regulation has now been put in place to limit the amount that banks can lend, to try to limit the level of money creation. Banks must now set aside a certain amount of “capital” every time they make a loan.
Capital can be in the form of interest bearing instruments such as Government Bonds, or a variety of other things. Government Bonds are pieces of paper that the government will exchange for money, and can be used to claim back the money over a period of time with some interest on top. This is how the government borrows money.
Capital can consist of many things, also including retained profits. Being able to use retained profits as capital means that every time a bank makes a profit, it can set some aside and use it as capital to make even more loans, on top of the additional loans it can make every time a customer repays and more capital is free to fund a loan.
In the current system of regulation, loans are given a “risk-weighting” depending on how risky the regulators perceive the loan to be. Business loans are given a 100% risk weighting, meaning that for regulatory purposes the level of capital currently required must be, for instance 8%, of the real value of the loan. The level of capital required is set to go up, and is being discussed currently by international regulators.
So, if a business borrows £1000, £80 of capital must be kept aside for a capital requirement of 8%, as the loan is risk-weighted at 100%. Mortgages are given a lower risk weighting, as if the homeowner cannot pay, the house can be sold to someone else. Mortgages are currently weighted at 35%. This means that a £1000 mortgage would only require the same level of capital that a £350 business loan would. It also means that a business loan must make a bank three times as much profit as a mortgage would, otherwise it will be a bad investment. It is not hard to see why so much money is pumped into housing with this situation.
This process is known as “capital adequacy”, supposedly ensuring that banks have enough capital to cover losses.

How banks get around the rules
I mentioned earlier that the level of money creation is effectively unrestrained; there are two particular regulatory practices that enable this. I talked about “capital” earlier, and certain things that it can consist of, one being retained profit. Banks are more or less guaranteed to make profit, and vast amounts of it, after all the bonuses and dividends have been paid and the rent for the branches is in order, there is some left over. This is added to the pile of existing capital, and can be used to make further loans. This in itself would not allow unlimited levels of loans to be made, only more and more as the banking sector grows in profitability.
The other factor is in something called securitization. This is the practice of effectively selling on a loan, passing the risk & reward onto someone else in exchange for cash, which can be used as capital. A bank packages up a large amount of loans, and sells them onto somebody else at a discount, the interest is then paid to the new owner of the loan, and the bank has freed up more capital by selling on the loan and can then make more loans.
The new process is slightly harder to understand, as the liquidity and solvency measures are now separate. The capital requirement is 8%, so a bank will be able to create 92% of the value of a loan for a business out of nothing, as the loan is weighted at 100%. For a mortgage, which is weighted at 35%, a bank can create over 97% of the value of the loan.

Clearing systems
When we talk about banks “creating money” by putting aside capital and adding numbers into a bank account for a loan, people sometimes say that the extra numbers are “credit”, and not “money”.
The clearing system is how this “credit” is transformed into money. When a bank makes a loan, and the loan is then spent and transferred into another bank account, the corresponding bank accounts decrease and increase respectively. Further to this, “base money” moves around. Base money is a special kind of money that only banks have access to, and in “clearing” it, they get to create the kind of money you and I use.
Imagine two sets of customers, two at HSBC, and two at Barclays. They are both making opposite transactions.
So for the first set of customers, £100 is going from HSBC to Barclays, and for the other set, £100 from Barclays to HSBC.
HSBC must transfer across £100 of base money to Barclays, and in the other transaction, Barclays sends £100 across to HSBC.
By using the clearing system, the banks can both keep their base money because in this transaction everything cancels out.
This means the banks didn’t need to have any base money to begin with to do the transaction.
Now imagine millions of people across the country all transferring money to each other across only a few major banks.
These banks can keep a tally in their computer systems, and usually the same situation above results at the end of each day, the banks don’t need to move around very much base money because it all cancels out.
Having access to this clearing system and the base money used within it means that banks can make loans many times greater than their stock of base money, as long as everything clears at the end of the day, banks can lend almost as much money as they like. If something goes wrong and for some reason everything doesn’t clear, the Bank of England can help out.
The Quantitative easing programme added hundreds of billions in base money to the system, meaning that at the time clearing became easier, but it has also meant that when confidence is restored, banks will be able to create a much greater quantity of money, because higher stocks of base money will make clearing safer for them.

I may have caused some confusion myself here. I wasn’t saying banks do not have to have deposits. In the USA, if I’ve got this right, all banks keep back 10 per cent of EXISTING money…..although I’m not sure if this could be just simply broad or digital money.

The bank borrows AGAINST these deposits…correct? It doesn’t actually lend from actual deposits placed with them?

The “Money as Debt” video seemed to suggest that, when person A takes out a loan, this credit is simply written into person A’s account, say $1000. Person A uses the loan to buy a Hi-Fi system from Person B. Person A pays by cheque (or check) and Person B deposits the cheque into their bank. The money is then transferred from Person A’s loan account to Person B’s account.

This is apparently totally incorrect. However are cheques for large amounts not cleared with digital money rather than existing cash money?

Sorry to be a pain on this subject, but I’d just like to get a few of my misconceptons cleared up if possible.

I would love to see a bank set up in the UK on a national level along the same lines as the Bank of North Dakota, that is, using money from state assets to finance loans .

The UK Labour Party proposed the idea of a national investment bank both in the 1960s and again in its 1983 election manifesto. If course, neither initiative ever got off the ground. A state bank could provide us with the money to get the real economy off the ground.

Of course, a central bank creating its own money and circulating it interest free at no cost to the taxpayer would, to my mind, the most preferable solution, that is, the government creating the money and spending it into society on much needed areas such as road, rail, housing and renewable energy.

948. May 17, Interview on Al Jazeera, in which Ellen Brown gives her critique of President Trump’s approach to infrastructure. Part of coverage of the U.S. Chamber of Commerce’s “Infrastructure Week”. Watch it here.

947. May 13, Bring On the Power of a Public Bank for CA: People’s Forum, L.A., 3 pm. Info here. At the beautiful PUENTE Learning Center DTLA in Boyle Heights: https://www.puente.org/locations/

946. May 2, presentation, The Web of Debt and the Deep State: How do we break Free? Info here.